Why did the United States leave the gold standard?
Basically, because the gold standard constrained the federal government. I get a lot of questions from students about
the gold standard. For example, what is it? And why don’t we have one anymore? I will
start by explaining what it is. Under a gold standard, the monetary unit is defined as
a certain amount of gold, like 1/20 of an ounce, or 10 grams. In the era of the international
gold standard, before World War I, the U.S. dollar was defined as a little less than 1/20
of an ounce of gold. To be precise, one ounce of gold equaled $20.67. A silver standard follows the same idea. The
British monetary unit, the pound sterling, originally meant exactly that: one pound of
sterling silver. A gold standard can operate with or without government involvement in
the minting of gold coins, the issuing of gold-backed paper currency, and the provision
of gold-backed checking accounts. Historically, private mints and commercial banks were reliable
providers of gold-denominated moneys. Thanks to the banks, a gold standard doesn’t
mean that people have to carry around bags of gold coins. Anyone who finds paper currency
and checking accounts more convenient can use those. But it does mean that if a person
wants to redeem a bank’s $20 bill or cash its $20 check, the bank is obliged to give
him a $20 gold coin. The obligation to redeem for gold guarantees the gold value of all
kinds of bank-issued money. And the purchasing power of gold was historically very stable.
By contrast, under today’s unbacked, or fiat, dollar standard, there is no value guarantee.
If you take a $20 Federal Reserve note to a bank, all you can get for it is other Federal
Reserve notes. The experience with fiat moneys in various countries has ranged from mild
inflation to terrible inflation. Why did the United States leave the gold standard?
Basically, because the gold standard constrained the federal government. The obligation to
redeem in gold limited money printing at times when the federal government, rightly or wrongly,
thought more money printing would be a good idea. The United States went off the gold
standard in two major steps. First, in the 1930s, under President Franklin Roosevelt,
the federal government broke its promise to redeem Federal Reserve notes in coin for U.S.
citizens. Private ownership and use of gold coins were
actually outlawed. Individuals and banks were ordered to turn in their gold coins and bullion
to the Federal Reserve. In the late 1960s and early 1970s the Fed printed dollars rapidly.
The falling purchasing power of the dollar triggered redemptions by foreign central banks,
and the U.S. government began running out of gold. Rather than stop printing dollars,
Nixon ended their redeemability in 1971. The money printing then accelerated, culminating
in double-digit inflation around 1980. By contrast, inflation under the classical gold
standard was never in double digits and averaged only 0 to 1 percent per year over the long
term. A common objection to a gold or silver standard
is that there can be random shocks to the supply or demand curves for metal and that
these will make the purchasing power of metallic money unstable. But historically this was
not much of a problem. For example, after the major supply shock of the California gold
rush of 1849, as the gold dispersed over the entire world, the resulting inflation was
less than 1.5 percent per year for about eight years. Thereafter the price level leveled
off and later gradually declined as the world output of goods grew faster than the stock
of gold. Under our current fiat standard, the supply of money is up to the decisions
of the Federal Open Market Committee. There is no self-correcting market tendency to prevent
the creation of too much money under that system. The fate of the dollar rests with
a handful of political appointees. The practical question is under which system
are the quantity and purchasing power of money more stable. In other words, which system
better limits inflation? The answer to that question is clear from the historical record.
Gold and silver standards have dramatically outperformed fiat standards around the world
in providing stable, low-inflation currency.